Undervalued companies in Italy

“In Italy the market has tarred many companies with the same brush, and as value investors we are always attracted by low prices," says David Harris, portfolio manager in SKAGEN Focus. Photo: Barn Images

The refugee crisis, a weak banking system that has long been weighed down by a large proportion of bad loans, slow and low growth combined with an unstable political situation – it is no wonder that Italy's stock exchanges have been turbulent. As expected, the market has reacted with volatility.

"Situations like this are always interesting to us. They create opportunities if you understand the risks and the companies' fundamental exposure," says David Harris, one of the portfolio managers of the global equity fund SKAGEN Focus. He has recently returned from a trip to meet a number of different Italian companies.

"Italy is a fantastic country with many interesting companies, run by strong entrepreneurs. I have brought several new investment ideas home with me which, after we have carried out the analysis work, will enter our library consisting of several thousand investment ideas. We study the ecosystems of the companies on a continuous basis, looking at the environment in which they operate, their competitors, etc. This gives us insight into many opportunities in the value chain and means that we are ready to act when opportunities arise in the future," he explains.

Unpopular Italian banks

Italy's largest bank, Unicredit, is an example of a company with promising opportunities. The company recently went through a re-capitalisation with a EUR 13bn right issue, in which SKAGEN Focus initiated a position.

The European Central Bank carried out a stress test on banks in the Eurozone last summer and Unicredit emerged as one of the weakest lenders. The company is still trading well below the book value of its net values.

However, there are signs that Unicredit may be able to improve profitability. Amongst other things, the bank has sold assets outside of its core operations for seven billion euros in order to strengthen the capital base. The new French CEO Jean-Pierre Mustier plans to close branches, reduce the number of employees, simplify the corporate structure and divest of portfolios with bad loans. He has already managed to strengthen Unicredit's position in just a short space of time. In May the bank reported a net result and earnings which were clearly above the market's expectations and which indicate that the bank is on the right track.

Guided by price and potential change

The SKAGEN Focus team is guided by the principle of "cheapness and change". In other words, if they are thinking of investing in a company, in addition to a low price tag, there must also be identifiable catalysts that may generate hidden values in the company:

"In Italy the market has tarred many companies with the same brush, and as value investors we are always attracted by attractive prices. We have many ideas for potential Italian companies, but we must be able to see an upside in the share price of at least 50 percent, as well as catalysts for repricing before they can compete for a potential place in our portfolio. Our fund is highly concentrated and consists of only 30-35 holdings," explains David Harris.

Telecom Italia is another company in the portfolio with a number of catalysts for repricing. In addition, Telecom Italia has a so-called discount on discount effect: you get a discount due to the unpopularity both of the country the company is listed in and of the sector the company belongs to.

24 percent of the company is owned by the media and telecom conglomerate Vivendi, which is in turn controlled by the French billionaire Vincent Bolloré. 75 percent of earnings come from the domestic market while the remainder comes from the operations in Brazil.

Telecom Italia is a self-help story, according to Harris. They have a new, dynamic CEO, Flavio Cattaneo, who has made a number of important investments and managed the company so it is now in a turnaround position. Alongside this, he has restructured in order to cut costs and started programs to increase profitability. The portfolio managers in SKAGEN Focus expect extremely attractive cash flows in the next two to three years.

Three generations in coffee

The third Italian company in the SKAGEN Focus portfolio is the coffee imperium Massimo Zanetti, which is family controlled by the third generation of the Zanetti family. The group owns other brands, including Segafredo espresso, Hills Bros and Bontea, amongst others, and was first listed in Milan in 2015.

Consumers are generally loyal to their preferred coffee brand, and Massimo Zanetti's tactic has been to acquire smaller, local coffee brands and then use their distribution network to introduce Segafredo coffee.

The company has been under-researched and has therefore flown below the radar of many investors. The share is attractively priced and the company has made great progress in differentiating operations and increased income by seven percent last year.

Zanetti has never before had any efficiency improvement programs on the agenda. As a result, the cost structure is not necessarily optimal and has so far been a disappointment. In the short term, they have been negatively affected by the higher price of coffee beans, but the catalysts for repricing are a price cut and a streamlining of the organisation. This is combined with diversification within a quickly growing single serve segment (coffee capsules, etc.).

"We have broad mandates and a time horizon that is generally longer than many others in the market. We are therefore not afraid of cyclical companies or turnaround situations. A long-term perspective is the alpha and omega for us as investors. It is only then that you can see things in the right perspective," says David Harris.

Italian companies currently account for around 8 percent of the SKAGEN Focus portfolio.

Historical returns are no guarantee for future returns. Future returns will depend, inter alia, on market developments, the fund manager's skill, the fund's risk profile and management fees. The return may become negative as a result of negative price developments.